Sunday, May 06, 2018

Musk vs Buffett: innovation or moats?

Warren Buffett and Elon Musk finally had some public disagreements which sound so natural given the men's very different ideas about business. To start with a difference, Buffett has been successful thanks to his purchases of undervalued companies; Musk has become successful by marketing an overpriced company so that it becomes even more overpriced.

Buffett has always emphasized that the companies he buys should have a sustainable competitive advantage or a "moat" (broad ditch around a castle, a Buffett metaphor). At a recent meeting, Elon Musk said that this opinion was "lame" and innovation was the key to the success of a business. Buffett didn't allow Musk the final word and opined that Musk won't beat Buffett's candy company anytime soon.

Musk tweeted that he's starting a candy company soon and he was being super, super serious – I think that he meant "cereal", at least Al Gore was "cereal" about the global warming (and ManBearPig). Musk's fans started to produce lots of pictures of Elon Willy Wonka.

These are two "almost pure" approaches to business – Buffett represents the old-fashioned reliance on reliable businesses and their traits that have passed the test of time; Musk represents the promises of disruption, potential for very fast expansion in coming years, and indeed, bubbles and manias where this obsession often leads because it's much easier to pronounce big words and get enthusiastic than to provably produce billions by hard work.

Both approaches have been important. If the Buffett approach were a little bit more extreme and dominating, there would have been no progress. If the Musk approach were a little bit more extreme and omnipresent, everything would have been just bubbles and P.R.

Different industries have different typical time scales of innovation – the timescale \(\tau\) after which the performance or profits increase by the factor of \(e\) or the expenses drop by a factor of \(e\) or something of the sort. For some kind of products, like candies, you don't have to watch the innovation every day. In some other fields, like the hi-tech stuff, you do have to follow what's going on every week.

I think that almost all the people who have been "science and technology geeks" as kids must have gone through the Musk phase at some point – and many of them got stuck in it. I have surely believed that the "innovations and know-how are almost everything" when I was a kid. Some buildings made of bricks are so "lame", if I use Musk's arrogant vocabulary, and so are almost all occupations of the ordinary people.

My writing is logical enough which is why you could have predicted that this sentence would say that I no longer believe in this "overwhelmingly dominating power of innovations", and that's exactly what this sentence wants to tell you. I changed my mind some decades ago. What happened?

Well, I wanted to calculate some specific numbers that would show how incredibly important was the innovation, know-how, thinkers, and innovators – almost all the "ordinary work" is negligibly important and may be basically saved if you use the state-of-the-art know how. Shockingly enough for me, the approximate calculation basically taught me that the innovation didn't matter so much.

In particular, the number of houses or apartments in the world equals several billions. We are surrounded by castles, factories, bridges, and other structures. Imagine that some catastrophe eliminates all the houses in the world, all the cars, candies, and machines to make candies, but we still possess all the books, papers, and documentation that shows how to make things in the most modern way.

Surely, I was assuming, if we have the newest know-how, we wouldn't need the centuries to rebuild everything again, right? Well, I was trying to organize the reconstruction of the destroyed world as a gedanken experiment and my conclusion was Yes, we would still need centuries for that. There has also been progress in architecture and construction of buildings and bridges but the progress simply hasn't been game-changing. It still took years for Russia to build the amazing Crimea Bridge. The construction is just a bit faster than it was centuries ago. The buildings have some technological advantages over their predecessors – but I think that what we build these days is generally uglier than the structures in 1890 and even 1650. On top of that, I often feel that we couldn't build things like the cathedrals that were built with much weaker technology and by a much smaller population. And it looks like it's harder for us to place people on the Moon today than half a century ago – despite the fact that a smartphone is more powerful than all the room-sized computers that Armstrong and Aldrin needed.

So we still need bricklayers, architects, and tons of other occupations whose technological progress is relatively slow, who do similar things as they did decades or centuries ago (and sometimes millenniums ago), and who are expected to pocket half of the GDP or something like that. You don't want to spend 10% on science and innovation because there aren't too many people who can really do research and development this effectively – and even if they did something like that, their usefulness would be smaller than if they do a regular job.

If buildings were demolished, we would need lots of construction workers and perhaps architects. Some planning in the ivory tower wouldn't be enough. And in some sense, the construction frenzy would be similar to what we see normally – except for the somewhat more intense rate.

OK, what about other fields? Transistors have been following Moore's law – the density gets doubled every 18 months or whatever was the recent figure. This doubling has slowed down and is expected to stop within a few years. But there are other quantities in which the progress continues exponentially. The cleverness of the software is improving, too. The bandwidth of the Internet – and the expanding mobile Internet – is still going up at an amazing rate. While every single quantity of that type may stop growing, one may still expect new types of progress that may continue exponentially. But we're never assured that some products will keep on evolving quickly.

The demand for expensive smartphones has arguably gone down. The features of the most expensive smartphones such as iPhone X no longer seem so essential. People are really satisfied enough with their phones that are 1-2 years old. Of course, this cooling trend may get more extreme very soon.

What about the candies? Musk treats this business as one that has nothing much to do with technological innovation so far – unless he joins the industry. But this is also a rather uninformed summary. The industry of products based on sugar did need lots of technological innovation. The video clip for the Czech 2009 EU presidency ended with a conductor throwing a sugar cube to the coffee – all the other famous Czechs do something else with the sugar cube. Well, a Swiss-born physician moved to Dačice, Moravia, Czechia, and he invented sugar cubes over there. There have been let's say dozens of technological inventions of comparable importance in the candy-and-sugar industry.

They looked modest but I actually believe that even the damn sugar cube is a more groundbreaking invention than any invention that has ever been made in Musk's engineering companies. Bob Lutz, an ex-boss of General Motors, has stated that Tesla has no secret sauce and I completely agree with that.

So Musk is painted as the representative of the extreme innovation, futuristic technologies etc. but Tesla is none of it. It is the producer of electric cars based on completely average technologies. There is nothing special about those cars. What's special is the degree of religious fanaticism that this company has created among its fans. This fanaticism is partly sparked by a certain extremism in the ideas about the future – they (ludicrously) say that in the foreseeable future, all cars will have to be electric, everything will run on batteries, and so on. But regular car companies such as the Volkswagen Group may still sanely believe that most cars will run on petrol in 10 years – but they may still make more competitive cars than Tesla, nevertheless. There is absolutely no contradiction here.

But there is really nothing new about the electric motors or batteries. They use ordinary lithium-based batteries that we've known for some decades. The same electric motors that have been included in cars for more than a century – basically the same period of time as the era of the combustion engines. There is no reason to expect the rational, (Tesla-)irreligious part of the world to suddenly embrace something that's been around for more than a century. The electric cars still have the same general disadvantages. The range is poor, the infrastructure to recharge is sparse and it's too expensive to make it dense, and there are lots of the extra "totally new" problems with the electric cars. In particular, even if you don't drive for some time, the battery gets discharged spontaneously. Imagine that half of the petrol in your car leaks and is gone if you don't use the car for several weeks. It creates extra expenses that are completely non-existent in combustion engines.

So there may be legitimate discussions about the relative importance of innovation vs moat. But the discussion between Musk and Buffett is actually a battle between overhyped claims about innovation and moat – and hype about innovation is something else than innovation. And be sure that moat is a more important trait for a good business among these two.

Buffett reminded Musk that the technological innovation hasn't really reduced the expenses in Musk's factories substantially. Well, I think that Musk knows very well that Buffett knows what he is talking about. Musk tried to replace almost all humans in his companies by robots. And it just doesn't work well. Musk had to admit that he has "underestimated humans". Right, "underestimating the value of humans" is a part of his business fallacies. There are some "intelligent working class" occupations – workers have become operators – that are still very useful to control the machines. The machines save most of the really hard, manual work. But there's a lot of room for a human operator who has common sense and knows how to achieve certain things by pressing buttons. And that human operator is doing a better job than machines that try to emulate him by artificial intelligence.

The replacement of such human operators by machines could only be game-changing if you had some complete, new, reliable setup in which it may be expected that the machines can do everything that the humans could. If you try to replace the humans by robots chaotically, just because you prefer robots over humans, you just can't expect any improvement – or at least no clear improvement. If it were so straightforward to replace the humans by machines and save most of the money, it would have already taken place almost everywhere. It hasn't taken place which is a good reason to think that it's not a miraculous cure that dramatically lowers expenses.

Henry Ford has invented the assembly line. It still needed some workers. You know, this was an example of a game-changing invention in the industry. The problem with Musk and some other, less visible people is that they haven't really invented anything analogous to the assembly line. They just pretend to be on par with Henry Ford without the actual beef. They just talk about the game-changing innovations. But they have none. And that's why the Musk-vs-Buffett isn't really a disagreement between innovations and moat. It's a conflict between hype and moat. And moat is a better foundation for business than hype. Innovation is an important trait for many good businesses. But managers and investors must be careful not to buy an empty impassioned talk about innovations as if it were innovations themselves.

In a classic Czech movie, a choleric anti-Nazi anti-communist father analyzed some metallic patterns and he gave "one year to the Bolsheviks, at most two". Given the cash burn at Tesla, and the increasing certainty that the stellar expectations have always been about a wishful thinking, naive and unrealistic planning, and uninformed arrogant opinions about many occupations in the industry, I also give it one year, at most two. It's a company that produces exponentially growing profits – unfortunately, negative ones – aside from promises that are bound to be untrue. But the lies have short legs, as a Czech proverb says. You can't run a sustainable business that depends on lies.